The Fed and the taper: Birmingham economist explains what just happened and why

It's big news for banking, business, and the global economy: the U.S. Federal Reserve has decided to taper.

For the Fed, tapering refers to a slow down -- imagine a river's flow tapering off. The Fed had been putting $85 million a month toward buying up financial securities, but will now slow that pace of buying to $75 million a month.

The Fed spends money this way in order to keep interest rates low. Low interest rates make it easier for businesses to borrow money, and that money can then be used to help expand production or acquire new machinery.

But the Fed can't buy up assets forever, due to inflation risk. For this reason, most market-watchers knew the taper was coming. But yesterday's announcement may have been a surprise for some.

Emma Dinsmore, chief economist at Birmingham-based R2 Macro, says the Fed made its move because the unemployment rate has come down, and while inflation is still in check it could become a problem later.

"The labor market has improved since the start of 2013," Dinsmore says. "The unemployment rate now stands at a considerably lower 7 percent," relative to the start of the year (7.9 percent).

Inflation remains low as well, Dinsmore says -- the Fed's current target is annual price increases of 2 percent. But with more asset purchases, inflation risk increases. As Dinsmore puts it, "The Fed will have to maintain a delicate balance of maintaining price momentum now but not spurring long-term inflation."

There had been some concerns that the Fed's move to taper would hurt stocks, which had a tremendous year in 2013. (The Dow Jones Industrial Average is up more than 23 percent so far this year.) But markets are actually up substantially over the past week, and Dinsmore expects equities to continue to do well into next year.

"These trends should be tremendously supportive of global equities and contribute to a very positive outlook for 2014," she says.